2016 (11) TMI 1008 - AT - Income Tax

Tribunal upholds tax authority's arm's length adjustments, emphasizing importance of transfer pricing regulations

Shell Global Solutions International BV Versus Deputy Director of Income Tax (International Taxation) -1, Ahmedabad

The Tribunal dismissed the appeals, confirming the arm's length price adjustments made by the tax authorities. It held that the base erosion argument was ... ALP adjustments non permissibility under Article 9 of the Indo Dutch Tax treaty - Held that:- While the relief in the cases of economic double taxation due to application of arm’s length standards under article 9(1) is available under article 9(2), no such relief is available, under article 9(2), in respect of the juridical double taxation caused by the application of arm’s length standards. That does not, however, matter. The non availability of relief under article 9(2) does not fetter application article 9(1). In a situation in which the residence jurisdiction has yielded limited source taxation rights to a type of income of an assessee, the mere increase in quantum of such a taxable income in the source jurisdiction, due to application of arm’s length principle, need not always be visited with corresponding adjustment under article 9(2) in the residence jurisdiction. In our humble understanding, the restriction to the effect that only economic double taxation can be remedied by the scope of article 9, as learned counsel urges us to infer, does not exist. In view of these discussions, as also bearing in mind entirety of the case, we see no merits in this new plea raised by the assessee. Given our above findings, it is not even necessary to take the judicial call on whether or not article 9 of the Indo Dutch tax treaty, or, for that purpose, OECD Model Convention, restricts or regulates the domestic transfer pricing legislation. That aspect of the matter is academic as on now, because, even if we are to hold that it does restrict or regulate the domestic law provisions on transfer pricing, the application of arm’s length standard cannot be declined because it is a case of juridical double taxation and not economic double taxation. However, as we deal with this interplay between article 9 and transfer pricing legislation, it is important to bear in mind the fact that there is a school of thought that a domestic arm’s length principle, which is what transfer pricing legislation represents, goes much beyond a tax treaty’s normal rule making scope since this arm’s length principle governs taxation of an enterprise in general and the tax treaties do not restrict domestic law in this respect. - Decided against assessee Issues Involved:1. Interplay of Article 9 of the India-Netherlands Double Taxation Avoidance Agreement (Indo-Dutch tax treaty) and Transfer Pricing (TP) adjustments under domestic TP law.2. Arm’s length price (ALP) adjustments and their impact on the income from fees for technical services (FTS).3. Base erosion argument against ALP adjustments.4. Treaty protection under Article 9 of the Indo-Dutch tax treaty against ALP adjustments.Detailed Analysis:1. Interplay of Article 9 of the Indo-Dutch Tax Treaty and TP Adjustments:The primary issue in these appeals is the interplay between Article 9 of the Indo-Dutch tax treaty and TP adjustments under domestic TP law. The assessee, a company incorporated in the Netherlands, rendered technical services to its associated enterprises in India, which were subjected to ALP adjustments under the transfer pricing regulations. The assessee argued that such adjustments result in the erosion of the Indian tax base and are contrary to the scheme of Section 92(3) read with Circular No. 14 of 2001. The Tribunal noted that the ALP adjustments are mandatory under Section 92(1) for international transactions, and the exclusion clause in Section 92(3) does not apply in this case. The Tribunal also highlighted that the Indian transfer pricing regulations do not provide discretion to the tax administration in applying the arm's length price in computing profits from international transactions.2. Arm’s Length Price Adjustments and Income from FTS:The ALP adjustments were made to the income from fees for technical services (FTS) received by the assessee from its associated enterprises in India. The adjustments were substantial, amounting to Rs. 100.03 crores over four assessment years. The assessee did not dispute the mechanics and quantification of these adjustments but opposed them on the ground of base erosion. The Tribunal emphasized that the ALP adjustments are necessary to ensure that profits taxable in India are not understated, and the provisions of Section 92(1) must be applied to compute income from international transactions at arm's length price.3. Base Erosion Argument:The assessee contended that the ALP adjustments lead to the erosion of the Indian tax base, as the additional fees charged would have been taxed in India at 10% while the same amount would be allowed as a deduction at 34% in the hands of the Indian payers, resulting in a net tax base erosion of 24%. The Tribunal rejected this argument, stating that the exclusion clause in Section 92(3) does not come into play as it only applies when the computation of income on an arm's length basis reduces the income or increases the loss of the assessee. The Tribunal also noted that the tax administration cannot predict whether the Indian AE will make sufficient profits in the future to offset the losses, making the tax shield argument hypothetical.4. Treaty Protection under Article 9:The assessee sought treaty protection under Article 9 of the Indo-Dutch tax treaty, arguing that ALP adjustments are not permissible except in the case of juridical double taxation and only in the hands of a domestic enterprise. The Tribunal admitted this legal plea but found it devoid of any legally sustainable merits. The Tribunal noted that Article 9(1) permits ALP adjustments when conditions between associated enterprises differ from those between independent enterprises, and the profits that would have accrued but for those conditions may be included in the profits of that enterprise and taxed accordingly. The Tribunal rejected the argument that Article 9(1) only applies to economic double taxation and not juridical double taxation, stating that the article's wording does not support such a restriction. The Tribunal also emphasized that the non-availability of relief under Article 9(2) does not fetter the application of Article 9(1).Conclusion:The Tribunal dismissed the appeals, confirming the ALP adjustments made by the tax authorities. The Tribunal held that the base erosion argument is not acceptable, and the treaty protection under Article 9 of the Indo-Dutch tax treaty does not preclude the application of domestic TP regulations. The Tribunal emphasized the mandatory nature of the arm's length principle under Section 92(1) and rejected the assessee's arguments on both the base erosion and treaty protection grounds. The judgment underscores the importance of applying transfer pricing regulations to prevent the erosion of the tax base and ensure that international transactions are conducted at arm's length prices.